Treasury bonds are risky bet

(China Daily) – The US Senate and House agreed on a $787 billion stimulus package to save the economy. The total US government debt, including bills, notes, and bonds and an estimated US federal budget deficit of $1.2 trillion, will amount to $2 trillion.

Some analysts believe scared global investors will shift to US treasury bonds, which are considered the “safest” securities, and certainly money has flowed into US treasury bonds since the financial tsunami broke out.

But the potential risks of treasury bonds are also accumulating.

If no other country’s central banks are willing to increase their holdings of US treasury bonds, and no international investor will buy them, exactly how the US government will finance its colossal economic stimulus plan is unclear.

The US Federal Reserve will inevitably act as the ultimate financier to bolster the economy. Under such an unconventional circumstance the Federal Reserve will likely to keep its nominal short-term interest rate at around zero. It has also pledged to expand its balance sheet to finance the government’s new stimulus plans. Once the US government starts implementing detailed stimulus measures, the Federal Reserve’s balance sheet is expected to further expand to $3 trillion.

The rapidly expanding national debt of the US will affect credit rating for US treasury bonds. US treasury bonds may become hard pressed to keep their AAA rating. The 10-year US treasury bond yield was an average 2.30 percent in January, the lowest on record.

US treasury bonds are supported by the nation’s credit but US national credit has been tainted in the financial crisis. In the short term, however, the US government can’t break away from the current borrowing-bailout-more borrowing cycle.

The US Treasury bond bubble is ballooning and is set to burst. Global investors are keeping a close eye on the mounting risks, but few expect the bubble to explode soon. They are waiting for the best time to dump the bonds. Many of them, however, think that it will be too late to leave the game when China and Japan decide to stop buying or begin selling the US Treasury bonds.

– US stimulus-related debt “could hurt investors,” China warns (Xinhua):“To rescue the ailing U.S. economy by increasing government borrowing will create a record-high federal deficit,” said Yu Zuyao, economist with the Chinese Academy of Social Sciences, a government think tank.
“This can further lead to catastrophic consequences such as serious inflation and U.S. dollar depreciation,” he said Tuesday.
China faced high depreciation risk to its foreign exchange reserves, U.S. Treasury bonds and other U.S. dollar-denominated assets, Yu said.
According to the U.S. Treasury, China held 681.9 billion U.S. dollars worth of U.S. government bonds as of November, and it bought another 14.3 billion U.S. dollars worth in December.
“Buying U.S. government bonds amid an economic downturn, [a purchase] that is not based on the sound performance of the U.S. economy itself, indicates a huge bubble,” said Zuo Xiaolei, chief economist of China Galaxy Securities.

– Jim Rogers: Treasury Bonds Last Bubble Left (Money News):Billionaire Jim Rogers says that investors will have to short government bonds, soon, as the amount of federal debt issued is “staggering” and inflation risks are now emerging.

– Jim Rogers (Fortune Magazine):
I’m now selling long-term U.S. government bonds short. That’s the last bubble I can find in the U.S. I cannot imagine why anybody would give money to the U.S. government for 30 years for less than a 4% yield. I certainly wouldn’t. There are going to be gigantic amounts of bonds coming to the market, and inflation will be coming back.

– Time to Sell Treasuries, Biggest Korean Fund Says (Bloomberg):
“It’s time to sell U.S. Treasuries,” said Kim, who took over as head of investments at the start of the year. “The stimulus plan may cause inflation. The U.S. will raise the benchmark interest rate.”

China’s financial security is banded tightly with US Treasury bonds, which are fast becoming a risky option.

[The author He Jun is an analyst with the Anbound Group, a Beijing-based consulting firm. The article is reprinted from China Business News.]